401k vs. Whole Life Insurance for Retirement Plans
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UPDATED: Apr 25, 2022
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- 401(k) retirement plans were established in 1978 to provide employees a functional retirement plan through their employment
- For the most part, the investment instrument that has been most popularly used for funding has been mutual funds, managed by an administrator. This has been a significant flaw in long-term planning as evidence by several marked crashes and market corrections
- Whole life policies that are purchased from a mutual company offers a very rich system of cash accumulation with tax-deferred buildup and tax-free payouts at retirement
- The whole life policy will show more available cash at retirement due to small fees and a tax-free payout, while the 401(k) must suffer through higher fees, market risk and full taxation at retirement at ordinary income tax rates
The 401(k) retirement system has been in place since 1978 when the United States Congress passed the Revenue Act of 1978.
With the passage of this legislation, an employee of a sponsoring employer could put away part of his or her earnings toward their retirement. Included in the law was a provision where the employer could match the employee’s contribution up to a certain amount.
All the money that goes into the 401(k)is “before tax dollars” which means that there is no Federal, State or local income taxes assessed against the contributions.
Also, the money that is invested in the 401(k)program accumulates on a tax-deferred basis but will be taxed as ordinary income upon withdrawal of the funds when the employee reaches retirement.
The advantage of the 401(k) concept is to provide employees the means of saving for retirement on a systematic basis on a tax-favored basis.
The funds of the retirement fund can be in various investments, but the trend has been to use mutual funds over the years, administered by an investment manager to maximize earnings over a period.
Millions of employees since the late 70’s have set aside millions of dollars and reaped the rewards of the multiplication of principle and interest which resulted in a satisfying retirement nest egg.
The negative of the 401(k) system is not necessarily in the system itself but in the discipline of the investments.
As noted, the predominance of investments is in mutual funds which are, of course, tied to the stock market which has the potential of great rewards if the market rises, but is also subject to losses if the market declines.
In 1987 there was a decline in the stock market that rocked the country with a 22 percent decline in one day. That day was called Black Monday, and many 401(k) devotees lost half of their years of investments in one day.
There was great clamor on that day, and all the pundits exclaimed that the 401(k) system was flawed and something must be done about it. But there was nothing done, and all the brokers said the market would come back, just be patient.
The market did come back, but when money is lost in the market, it is gone forever, and as an investor, you are starting all over again from a new low.
Nevertheless, the 401(k) retirement system is alive and well, even with subsequent “corrections” and crashes since 1987.
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Whole Life Insurance
Whole life insurance enjoys some special tax advantages that make this vehicle a superior method for the accumulation of money over a long period.
Whole life is pilloried by the investment community as a pariah and as a lousy investment. Consequently, there is an ongoing controversy as what is a good investment.
Suffice it to say that whole life insurance is the type of life insurance that has a level premium until age 100 and grows a cash value that builds inside of the insurance policy.
Life insurance enjoys another major perk in that money that is input into the policy accumulates on a tax-deferred basis, and when it is taken out as a loan, there is no income tax charged to the owner, unless the policy has lapsed.
There are two types of life insurance companies in the world, and those are stock companies and Mutual companies.
The participating life insurance companies pay dividends back to their policy owners, which are not guaranteed, but over the years have proven to be quite profitable to the policyholders.
Dividends can be taken in cash, they can reduce premiums, they can accumulate with interest, or they can be used to purchase paid-up additional insurance.
It is the latter option that has sparked the most interest because not only does this option create additional death benefit, it also creates more inside cash that grows tax-deferred.
So what the mutual life companies have done is to create a paid up additions rider which is just like the policyholder putting in extra cash which is what happens.
The result is that a good bit of money can be set aside, and just enough extra cash can be put into this tax-deferred device so that it remains a life insurance policy, so maximum allocation for retirement is accomplished.
Once retirement age is achieved, the money can be borrowed from the policy for retirement purposes, with no income tax being assessed because the money coming out of the policy is a loan.
There will never be any worry about a falling market or fluctuations in a person’s retirement funds. The life insurance companies that offer this kind of contract are some of the wealthiest business corporations in the world and are backed by billions of dollars in reserves.
They have faithfully paid dividends over the past 100 years or so, even during the depression of the 1930’s.
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Which form of retirement plan is superior to the other?
- Market Volatility – The 401(k) plan is subject to the whims of the stock market. The whole life insurance plan will always have steady growth.
- Management Fees – The 401(k) plan will not only have management fees for the administration of the plan, but there are mutual fund fees. The fees for the whole life insurance are built in and do not fluctuate, and they are usually smaller in total.
- Death Benefit – The 401(k) plan will have a death benefit which will total the amount of cash that is held in the plan. When it is paid to the beneficiary, it will be taxable as ordinary income. Proceeds can come out in a lump sum, paid out on an extended basis, or rolled over to the beneficiary’s 401(k) plan or an IRA. The Whole Life death benefit is received income tax-free.
- Disability – If a worker is disabled and has a 401(k) plan, his contributions will not be made while the disability lasts. The whole life policy has a waiver of premium feature which will make contributions while the disability lasts.
- Taxation of Proceeds – The payout at retirement for the 401(k) recipient is fully taxable as ordinary income. The payout at retirement for the whole life recipient is received tax-free.
Even though the 401(k) plan uses before-tax dollars, which allows for a robust amount of money that goes into the plan, that advantage is negated to a large degree by fees.
But the main advantage goes to the Whole Life Plan where the money comes out to the retiree tax-free.
When the death benefit advantage is considered with the disability feature, an accumulation of cash that is roughly one-third more to double the available funds for the whole life plan, all things being considered on an equal basis.
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